There are two pillars of retirement income in the United States. The first pillar involves Social Security a mandatory program covering most workers. The second system involves voluntary defined contribution pension plans. This section starts with a basic description of the Social Security system and private defined contribution retirement plans.

The Social Security program has been highly popular with Americans and many retirees are highly dependent on this government-run program. However, the Social Security system is running shortfalls which will lead to automatic benefit cuts around 2035. Defined contribution pension plans — 401(k) plans and IRAs — have over the last 40 years become the dominant vehicle for private retirement savings.

Many people forego investing in 401(k) plans and IRAs even though these plans provide generous tax benefits to savers. The failure of many people to fully invest in tax-deferred retirement plans puzzles many financial advisors. The analysis presented here indicates that saving for emergencies and reducing debt is and should be a higher financial priority than saving for retirement for many people.

Several changes to rules governing retirement savings accounts which would allow more people to save for retirement while aggressively reducing debt and preparing for emergencies are presented here.

Allow tax-free and penalty-free distributions on a portion of total contributions (perhaps 25 percent) for emergencies, student debt reduction, mortgage restructuring and long term care expenses prior to age 59 ½

Allow for some tax-free and penalty-free distributions for paying off the mortgage for people over age 50.

Eliminate all other distributions from 401(k) plans prior to the age of 59 ½.

Prohibit 401(k) loans.

Prohibit states from denying Medicaid and food stamp benefits for low-income people with 401(k) assets.

This proposal could be paid for by imposing a haircut on tax exemption for 401(k) contributions. (Currently, 100 percent of contributions to a 401(k) plan are exempt from income tax. The new rule would exempt 85 percent of contributions.)

People without access to an employer-sponsored retirement plan have substantially lower retirement savings than people with access to retirement plans at work. We consider ways to expand retirement savings for people without employer-based retirement savings. Specific proposals include:

Equalization of contribution limits between IRAs and 401(k) plans.

A rule change allowing firms without 401(k) plans to contribute to employee IRAs.

A rule change allowing firms to compensate contractors and employees of contractors with non-taxed fringe benefits including contributions to IRAs.

According to the trustees of the Social Security system, financial imbalances impacting Social Security stemming from the decrease in the working-age population will result in automatic cuts to Social Security benefits around 2034. In my view, it will be difficult to implement any compromise that reduces Social Security fiscal imbalances and prevents future automatic cuts to benefits without first increasing private retirement savings and reducing the dependence on Social Security. The final chapter of this section outlines and reviews some policy proposals related to improving the Social Security system.